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Global Banking & Capital Markets Key themes from the 1Q 2016 earnings calls June 2016

Contents

1 | Revenues and profitability falter in what should have been the strongest quarter of the year

2 | Market challenges impacted trading,

investment banking and wealth management segments

3 | North American banks boost

provisions, while European banks highlight lower cost of risk

4 | Will banks accelerate expense

initiatives to offset weak revenues and drive improved ROE performance?

6 | Methodology

Top 10 themes: a year-over-year comparison

1Q 2016 1Q 2015

1 Earnings performance 1 Earnings performance

2 Macro-environment 2 Macro-environment

3 Expense trends 3 Expense trends

4 Capital 4 Capital

5 Credit quality trends 5 Regulatory and compliance

6 Regulatory and compliance 6 Lending trends

7 Lending trends 7 Cross-border activities

8 Innovation 8 Credit quality trends

9 Cross-border activities 9 Acquisitions and divestments

10 Acquisitions and divestments 10 Innovation

Global Banking & Capital Markets – key themes from the 1Q 2016 earnings calls |1

Main topics discussed in the 1Q 2016 earnings calls

Revenues and profitability falter in what should have been the strongest quarter of the year

“1Q 2016 was extraordinarily challenging for the global capital markets and for the industry. While there has been improvement in the last month or so, there remain a number of macroeconomic and geopolitical risks to the global markets and the global economy. As such, we would expect the revenue environment to remain challenged in 2016.”

— Marcus Schenck, CFO, Deutsche Bank

• Banks faced an extremely difficult operating environment in 1Q

2016.

• Despite macro challenges, most banks were able to maintain

strong capital and leverage ratios …

• … However, trends in profit drivers were markedly less resilient.

• Revenue weakness reflected extreme market volatility in January

and February.

• Concerns about credit quality escalated sharply, although higher

provisions were more evident at North American banks with

exposure to the oil and gas sector than in Europe.

• Expenses remained high, driven by investments in regulatory

compliance and digital initiatives.

• Returns on equity (ROE) were down at most of the banks included

in this analysis.

In 1Q 2016, positive earnings performance was elusive. Net

income was down at almost all of the banks included in this

analysis. While there were a few instances of improved results —

Macquarie Group reported record full-year earnings; Bank of New

York Mellon, BNP Paribas and Société Générale reported an

increase in quarterly earnings from 1Q 2015; and Royal Bank of

Scotland turned in a narrower net loss — the prevalent trend for

1Q 2016 was disappointing performance.

Typically, the first quarter of the year is the strongest for the

banking sector. However, in January and February 2016, banks

around the world faced stiff headwinds from a range of macro

challenges that significantly curtailed client activity levels and

impacted revenue performance. Market conditions eased

somewhat in March, but by then it was too late to reverse the

impact on 1Q 2016 profitability.

The weak start to the year does not bode well for the rest of

2016. Anxiety about global economic growth, the trajectory of oil

prices and geopolitical issues remain firmly in place, clouding the

revenue outlook for the year and raising questions about whether

banks should be doing more to cut costs and reposition their

businesses. Notably, management at many banks did not appear

to be optimistic about near-term prospects:

• Bill Winters, Group Chief Executive, Standard Chartered: “Is the

economic environment going to stay as relatively benign as it has

been for the past month or is it going to look more like January and

February? We don't know.”

• David Mathers, CFO, Credit Suisse: “This is a very challenging macro

environment. Some of the conditions that obviously resulted in 4Q

2015 being difficult and 1Q 2016 being difficult could easily recur in

the balance of this year. There are still the same macro effects that

we saw in the first quarter. So just be cautious.”

Return on average equity, 1Q15 vs. 1Q16

Source: SNL Financial; *Data for ING is Return on Average Common Equity (ROACE)

See acronyms key at the back page

(1.6

)

1.4

2.2

2.5

2.5

2.7

3.7

3.8

4.2

4.4

5.0

5.2

6.0

6.4

6.5

6.8

6.9

7.1

7.6

7.8

9.0

9.1

9.2

10

.4

11

.8

13

.0

13

.3

15

.3

18

.1

19

.9

24

.8

NO

M DB

CA

CB

K

RB

S

CS

UC

G

BA

C

BA

RC

LL

D

UB

S

GS

MS C SG

ST

T

INT

BB

VA

BN

P

SA

NT

JP

M

HS

BC

BK

ING

*

WF

C

US

B

TD

RB

C

CIB

C

ITA

U

AX

P

Return on average equity (ROAE)

1Q16 1Q15


Market challenges impacted trading, investment banking and wealth management segments

“Markets were challenging, equity issuance was effectively non-existent and retail activity was extremely subdued, reflecting the many uncertainties with which investors grappled.”

— James Gorman, CEO, Morgan Stanley

As expected, trading revenues tumbled when compared to the first quarter of 2015. The steep decline was partially due to the fact that last year’s first quarter performance benefited considerably from the Swiss National Bank’s move to decouple the Swiss franc from the euro. The bigger problem, however, was the extreme market volatility driven by macroeconomic uncertainties in the first two months of 2016. Trading woes were exacerbated by a drop in investment banking revenues, as companies delayed IPOs, equity issuance and M&A plans amid the market turbulence.

Weakness was also evident in banks’ wealth management

operations, which normally help to offset more volatile performance

in wholesale segments. Many banks reported lower transaction and

incentive fees as clients fled to the sidelines.

• UBS reported “the lowest level of transaction volumes recorded

for a first quarter.”

• At Citigroup, CFO John Gerspach noted: “The first quarter is

historically a strong period for wealth management in Asia, with

higher transaction activity driving strong investment sales

revenues. Given weak investor sentiment during the quarter, we

didn’t see the typical rebound in transaction activity, and

therefore, our wealth management revenues declined

significantly from last year.”

• Goldman Sachs CFO Harvey Schwartz said 1Q 2016 was “the

first quarter in a while that we faced significant headwinds

across each of our business segments.”

• Deutsche Bank’s wealth management revenues were down 8%

from 1Q 2015. CFO Marcus Schenk said: “The decline versus the

first quarter 2015 was driven by lower performance and

transaction fees as a result of the current market environment,

with lower client activity.”

Percentage change in Fixed Income, Currencies and Commodities (FICC) and Equities trading revenues from 1Q 2015

Source: Company reports


(82)%(76)%

(56)%(47)%

(33)% (29)%(23)%

(14)% (13)% (11)%

2% 2%

17%

(29)%

(1)%(10)%

(23)% (20)% (29)%

(41)%(34)%

(5)%

(19)%(13)% (9)%

(37)%

CS NOM MS GS UBS DB BNP HSBC JPM C BARC BAC SG

FICC Equities


North American banks boost provisions, while European banks highlight lower cost of risk

“The cost of risk stands at 46 basis points versus 64 basis points in 4Q 2015. … From a historical point of view, you have to go back before the beginning of the financial crisis to find such a low level of cost of risk.”

— Philippe Heim, Group CFO, Société Générale

During the 1Q 2016 earnings season, management at banks across

regions highlighted a continuation of positive trends in overall credit

quality. Lower non-performing loan (NPL) ratios, higher coverage

ratios, a drop in new impairments and lower cost of risk in Europe all

point to a normalization in the credit cycle and more rigorous

underwriting standards.

Despite this, analysts appeared to be worried about the adequacy of

banks’ provisions amid lower commodity prices and slower global

economic growth. As a result, credit quality emerged as the single

most dominant topic discussed in earnings calls around the world.

Of particular concern was banks’ exposure to energy borrowers in

North America. Many banks have been forced to build reserves

against oil and gas portfolios faster than anticipated as falling oil prices

have put energy borrowers under considerable stress. Not only has

this raised concerns about the potential for a new credit crisis, it is

also taking place in a low revenue growth environment, essentially

amounting to a one-two punch on bank profitability.

Other portfolios that are being carefully monitored include shipping;

metals and mining; New Zealand dairy; and selected economies such as

Brazil, Indonesia and Russia.

Management acknowledged that there are pockets of stress that they

are closely monitoring for further deterioration, but defended the

strength of their provisioning. In contrast to their cautious stance on

revenue prospects, many provided an optimistic outlook for overall

credit quality trends.

• John Stumpf, CEO, Wells Fargo: “While deterioration in the oil and

gas portfolio drove a $200 million reserve build, the rest of our

loan portfolio continued to have strong credit results.”

• Marcus Schenck, CFO, Deutsche Bank: “Loan loss provisions

increased by €87 million in the quarter, reflecting specific events

in a few portfolios. Overall, the outlook for our credit portfolio

remains relatively benign.”

• Gary Lennon, Group Executive, Finance, National Australia Bank:

“After several periods of declining new impaired assets, we’ve

seen an uptick in the first half 2016 to AU$1.3 billion with the bulk

explained by two key impacts; AU$522 million relating to the New

Zealand dairy exposures and AU$358 million relating to the four

large single names exposures which have specific provision

coverage of circa 50%. Collective provisions (CP) coverage to

credit risk weighted assets remains peer leading and is broadly stable at 0.98%. As I dig into a couple of areas of interest around asset quality, the resources sector is facing some challenges and we are alert to this. But overall we remain comfortable with our position.”

Percentage change in provisions for credit losses or cost of risk from 1Q 2015

Source: Company reports


(39)%

(27)%

(23)%

(21)%

(19)%

(15)%

(10)%

(6)%

(6)%

(6)%

7%

15%

25%

30%

31%

39%

40%

52%

77%

79%

90%

104%

ING

BNP

UCG

BBVA

CA

SG

INT

CBK

SANT

LLD

C

BARC

USB

BAC

ITAU

DB

CIBC

RBC

TD

WFC

JPM

HSBC


Will banks accelerate expense initiatives to offset weak revenues and drive improved ROE performance?

“There is no magic bullet that can fully offset material revenue headwinds without compromising sustainable profitability or, in fact, the future of our franchise. Therefore, we will continue to carefully balance our investments in structural growth with tactical adjustments to our cost base to mitigate the cyclical headwinds we are facing.”

— Sergio Ermotti, Group CEO, UBS

In 1Q 2016, 23 of the banks included in this analysis reported a

decline in expenses from the year-earlier period, which would appear

to indicate that most are making progress on expense management.

However, of the banks that cut costs, only eight actually achieved

positive operating leverage. In an environment where revenue

prospects are muted at best, one of the primary levers for boosting

profitability and ROE is to keep the rate of expense growth well below

revenue growth.

But, even with the lack of success on this front in 1Q 2016, only a

few banks appeared to be willing to adjust the pace of reductions or

take additional measures to improve efficiency. Nomura launched a

strategic review of its businesses in EMEIA and the Americas, Lloyds

Banking Group accelerated its cost plans and Deutsche Bank is

“looking into potentially accelerating some of the cost measures that

we have planned until the year 2018 as a reaction to what we’re now

seeing in the market.” At Société Générale, Group CFO Philippe Heim

announced a plan intended to deliver €220 million in additional cost

cuts in Global Banking and Investor Solutions (GBIS).

The more common response to questions about what more could be

done on costs in the ongoing low growth environment was to take an

incremental approach to savings. Management appeared unwilling to

launch new drastic expense reduction measures to counter what they

view as cyclical revenue weakness. At some banks, there even seemed

to be a reluctance to fine-tune their current approach to expense

management. Many cited regulatory compliance costs and ongoing —

and necessary — investments in innovation as a barrier to efficiency

improvements.

• At U.S. Bancorp, the efficiency ratio has risen almost 300 basis points in the past three years. Nevertheless, CEO Richard Davis is reluctant to cut investments: “Nothing has gone in our industry’s favor in the last five years. … But we are [not going to] a 52% efficiency ratio by suffocating the company and not investing and then having to explain two years from now why we didn’t invest.”

• HSBC Group Finance Director Iain Mackay noted that “two bad months at the beginning of 2016 aren’t really the basis on which we’d make a decision that affects the long-term future of the Group.”

• Goldman Sachs CFO Harvey Schwartz said non-compensation costs

were at “the lowest quarterly level since 2Q 2009.” However,

revenues were at a four-year low, offsetting any earnings tailwind

lower costs might have provided.

The operating backdrop that characterized 1Q 2016 was clearly

much tougher than the markets and banks had anticipated. And

while the near-term outlook has improved slightly, analysts and

banks alike remain cautious about prospects for the remainder of the

year. At the same time, management at global banks do not expect

the 1Q 2016 environment to represent the new normal for the

industry, and as such, most appear to be willing to wait out the cycle

instead of tackling structural cost issues more aggressively.


Percentage change in revenues and expenses from 1Q 2015

Source: Company reports; banks inside yellow circle with yellow markers had positive operating leverage (revenues grew at a higher rate than expenses)


AXP

BAC

BARC

BBVA

BNPBK

C CA

CBK

CIBC

CS

DB

GS

HSBCING

INT

ITAU

JPM

LLD

MS

NOM

RBC

RBS

SANT

SG

STAN

STT

TD

UBS

UCG

USB

WFC

(45)%

(35)%

(25)%

(15)%

(5)%

5%

15%

(40)% (30)% (20)% (10)% 0% 10% 20% 30%

Re

ve

nu

e g

row

th

Expense growth

HIgher revenues; higher expenses

HIgher revenues; lower expenses

Lower revenues; lower expenses

Lower revenues; higher expenses


Methodology The purpose of this review is to examine the key themes discussed among 35 global institutions operating within the banking and capital markets (BCM) sector during the 1Q 2016 earnings reporting season.

Acronym key

ANZ — Australia and New Zealand Banking Group

AXP — American Express Company

BAC — Bank of America

BARC — Barclays

BBVA — Grupo BBVA

BK — Bank of New York Melon

BNP — BNP Paribas

C — Citigroup

CA — Crédit Agricole

CBK — Commerzbank

CIBC — Canadian Imperial Bank of Commerce

CS — Credit Suisse

DB — Deutsche Bank

GS — Goldman Sachs

HSBC — HSBC Holdings

ING — ING Groep

INT — Intesa Sanpaolo

ITAU — Banco Itaú

JPM — JPMorgan Chase

LLD — Lloyds Banking Group

MAC — Macquarie Group

MS — Morgan Stanley

NAB — National Australia Bank

NOM — Nomura Holdings

RBC — Royal Bank of Canada

RBS — Royal Bank of Scotland

SANT — Banco Santander

SG — Société Générale

STAN — Standard Chartered

STT — State Street

TD — Toronto-Dominion

UBS — UBS Group

UCG — Unicredit Group

USB — U.S. Bancorp

WFC — Wells Fargo

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© 2016 EYGM Limited. All Rights Reserved. EYG no. 01728-164GBL

1605-1930868 ED None

This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax or other professional advice. Please refer to your advisors for specific advice.

The views of third parties set out in this publication are not necessarily the views of the global EY organization or its member firms. Moreover, they should be seen in the context of the time they were made.

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Contacts

Bill Schlich Global Banking and Capital Markets Sector Leader +1 212 773 3233 [email protected]

Laura Tayman Banking and Capital Markets Analyst +1 720 931 4450 [email protected]

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